What the Heck’s Going on with the New Global Reserve Currency, the Chinese Yuan?

A “structural change”: capital flight in yuan.

The Chinese yuan fell to 6.722 to the US dollar currently, the weakest since September 2010. It’s down 3.3% so far this year. OK, a squiggle compared to the wholesale drubbing the UK pound has been taking since the Brexit vote, but there’s a difference: the yuan gets managed with an iron fist.

Some folks interpret this to mean that the People’s Bank of China has been weakening the yuan to gain some trade advantages and revive the export boom and kick economic growth back into gear. But evidence is piling up that the PBOC instead has been trying to slow down the yuan’s descent.

And this happened just days after the yuan joined the IMF’s special drawing rights (SDR) basket of reserve currencies, a huge milestone for the Chinese government that has been laboring on the internationalization of the yuan for years, mostly in tiny baby steps.

But the yuan is up against the mega-problems in China’s debt plagued economy, and it’s pressured down by enormous and, it turns out, not officially disclosed capital outflows.

“If that trend persists, expect further yuan weakness versus the greenback,” wrote Krishen Rangasamy, Senior Economist Economics and Strategy at the National Bank of Canada.

While a weaker yuan would be positive for exporters, it leaves many Chinese companies in an increasingly precarious situation: they have issued over $1 trillion in dollar-denominated debt, according to the Bank of International Settlements. And that dollar debt becomes increasingly difficult to service with a shrinking yuan.

This chart from NBF Economics and Strategy, shows foreign-exchange reserves (blue line, left scale, in $ trillions) edging down to $3.185 trillion in August, the lowest since 2011. Note how the decline started in mid-2014, and how so far this year, reserves have remained relatively stable, with a slight downward slope.

The chart also shows that net capital outflows (red line, right scale, in $ billions) so far this year, have ranged from $40 billion to $80 billion every month, or about $550 billion in outflows, according to Bloomberg’s estimates. But it’s not showing up in the foreign-exchange reserves. So something doesn’t add up (click on the chart to enlarge):

Turns out, another form of capital outflow is taking on increasing importance – and this is putting direct pressure on the currency: outflows in yuan that get converted into dollars offshore.

The People’s Bank of China limits how much companies can convert into dollars onshore. So companies move yuan offshore and then convert them into dollars. Thus, this selling of yuan doesn’t drag on China’s foreign-exchange reserves, but it exerts downward pressure on the currency instead. Bloomberg:

While the nation’s foreign-exchange reserves have stabilized and lenders’ net foreign-exchange purchases for clients have fallen close to a one-year low, official data show that $27.7 billion in yuan payments left China in August…. Such large cross-border moves can’t be explained by market-driven factors and need to be taken into account when measuring currency outflows, according to MK Tang, Hong Kong-based senior China economist at Goldman Sachs.

Goldman Sachs started including yuan funds in its analysis of outflows in July, after noting that cross-border movement of the currency masked actual pressures. The bank estimates that 56% and 87% of outflows took place through the offshore yuan market in July and August, respectively.

“There have been $265 billion in net yuan outflows since last October through August, primarily due to trade settlement in yuan,” said Goldman’s Tang, citing data from the People’s Bank of China and the State Administration of Foreign Exchange.

Raymond Yeung, chief economist at Australia & New Zealand Banking Group in Hong Kong called the outflow this year dominated by yuan “a structural change.” Given that currency conversion is no longer taking place onshore, he said, “we are not surprised that the foreign reserves have been preserved.”

But this offshore conversion of yuan into dollars is putting pressure on the currency in the offshore markets. Seeing this and expecting further declines in the yuan, companies might ratchet up the outflow of yuan and offshore conversion into dollars. Thus, capital flight takes on this new twist, made much easier by the yuan’s growing status as a global currency.

Yet, it would put further pressure on the yuan, turning its expected decline into a self-fulling prophecy – a decline that the PBOC is trying to manage with its iron fist, rather than letting it turn into a rout, such as the UK pound is experiencing. But if the PBOC loses control of the currency and a yuan rout sets in, now that it is a globally traded currency, the global fireworks would be a sight to behold.

Post navigation

64 comments for “What the Heck’s Going on with the New Global Reserve Currency, the Chinese Yuan?”

steve brassey

Oct 11, 2016 at 6:26 pm

those of us who remember the late ’80’s and how Japan was going to rule the world, remember how they bought the top of the Rockefeller Center, Hawaii, and Pebble Beach, only to puke them all out at 50% less to the local operators who out-smarted them, can now only say that all the hype on the neophyte quasi capitalist, but deep down inside, still Communistic command bureaucrats, just can say deju vu. Sorry for the sloppy and unruly comments, but I think you get the picture.

sinbad

Oct 11, 2016 at 7:47 pm

Try reading up on the Plaza accord, the US forced Japan to revalue its currency so Japan could not compete with the US.
You can get much farther with a kind word and a gun than you can with a kind word alone. (Al Capone)

NotSoSure

Oct 11, 2016 at 8:05 pm

+1. Without the US forcing the issue, most of us would be speaking some Japanese by now. Here’s a quote from Ilargi that describes the regular American state of mind:

“What the debate made clear once more is that America stands face to face with itself, it’s looking in a giant mirror, one which -only- in choice moments does not contort its own image, and America finds there’s nothing to like about what it sees in those brief moments in that mirror. And then therefore immediately proceeds to contort that image like it’s used to doing.

America may not like to look at its own stone cold hard reality, but it’s better than any culture ever in painting a picture of itself that it does like. In fact, it’s the first nation ever that made exactly that its main goal in life.”

America in 2 paragraphs. No one can write that well.

Chicken

Oct 11, 2016 at 10:06 pm

Certainly the “weak and ineffective” insider enablers and all their best thinking have brought the country/world to where we are today.

rich

Oct 11, 2016 at 8:09 pm

The Plaza Accord was an agreement to devalue the USD against the yen and the mark. The USG promised a minor devaluation, but the Japanese and the Germans got played for much more.

Chicken

Oct 11, 2016 at 9:38 pm

This could be a key point of the panoramic, combined with the globalist interests trade agreements such as NAFTA.

shaba

Oct 11, 2016 at 10:22 pm

Fuzzy memory but I read somewhere the simplified version was the Plaza Accord devaluation ended up encouraging ‘strong’ Yen holders to invest in the US. Then, when Wall St blew up in 87, the Japanese took what was left and sent it back to Japan. With limited options about where to invest, it fuelled a Japanese stock boom, until it went bust in 89 and hasn’t recovered to this day.

nick kelly

Oct 11, 2016 at 11:16 pm

The US in its brilliance did a deal with Japan limiting car imports- limited to the NUMBER of units- not their value.
Result- Japanese cars moved up market big time and have now eclipsed US in luxury- their only real competitor being Germany.
BTW: I believe but will check that the Plaza Accord involved more than Japan.

Unitron

Oct 12, 2016 at 8:37 am

Poor Japan, after spending hundreds of billions of dollars to weaken the Yen to help companies that couldn’t compete in an unfettered currency system, still ends up trillions in the hole, terrified that a Yen that strengthens too much more will wipe out their auto industry, can’t help but do everything it can to keep it on life support. The clock is ticking, Toyota, soon the game won’t be rigged anymore, and the time will come to sink or swim.

chris Hauser

Oct 12, 2016 at 9:06 pm

i’ll sell you the waldorf for $2B, wait, someone beat me to it.

rich

Oct 11, 2016 at 8:04 pm

If you want to see a real bloodbath, check out this Mexican Peso vs USD chart. Some folks blame it on the Trump effect, but Mexico’s problems are probably a bit more systemic than that.

When I was working in Mexico City back in the late ’80s, I got half my pay deposited in my account in the states. The joint venture partner pais the other half. The way I was paid was using a set bank’s (I think it was Banco de Comercial) exchange rate at noon on payday. My check went up every payday! We had to change prices weekly at least. The peso’s problems are MUCH deeper than Trump!

Chicken

Oct 11, 2016 at 9:32 pm

Perhaps this confirms Trump is correct about at least one thing. I seem to recall the Mexican government relies (or used to ) on Petrobras for a substantial bit of revenue.

I doubt the Mexican Government would be relying on Petrobras for anything really – you see the key is in the name there……..

Pemex…. maybe….

Petunia

Oct 12, 2016 at 9:57 am

Cemex, the Mexican cement producer was the biggest in Florida, as I recall. They are also big in other American markets, having priced out local producers. I remember seeing them all over south Florida, all of their drivers were Latinos, probably all Mexican.

Mexico has slowly under priced American companies, right here at home. Mexicans companies in the US are just as pervasive as Mexicans.

Ptb

Oct 11, 2016 at 10:10 pm

DXY is moving up again as well.

Green Rock

Oct 12, 2016 at 10:00 am

Mexico wouldn’t have nearly the peso problem if Hugo Salinas Price was right: Mexico needs to create their own silver money. Problem is, the US won’t let them.

Federal Reserve running the show globally. Poverty is all part of the plan. Nothing will really change for any of these countries until the Federal Reserve & Exchange Stabilization Fund is disabled.

Bookdoc

Oct 11, 2016 at 9:39 pm

They did as Pemex-at least that was what it was called at the time-sold enough and the money was used to subsidize gas, milk and soft drink prices. AT least that was what the English news reported. As a nationalized business, its efficiency was a joke. Now I believe remittances (hint-tax those to build the wall) are now very important.

Chicken

Oct 11, 2016 at 9:53 pm

So now the Yuan is back to 2010 lows (low and behold), this is the equivalent of a paycut for Chinese factory workers. Assuming Karma cleanser describes what goes around comes around then US citizens are expecting a pay increase while watching their import trade deficit balloon?

Oh please…. provide some historical example oh ye of infinitely short memory, me thinks the common denominator is imaginary.

Yeah, well one of those is indexed to the US dollar! It’s the Yuan of course. It should not be viewed as a stable currency as it has not established an equilibrium of its own. It is a manipulated currency.

It’s my guess China wants to devalue as it faces steep competition from Vietnam, Indonesia, etc. If the Yuan is dropping then the Chinese want it to devalue.
We’re talking about a police state that can execute anyone at will with no repercussions.

So again, if the Yuan is tanking, the Chinese want it to tank!
1 Trillion in US linked debt sounds rather small to me.

MC

Oct 12, 2016 at 1:55 am

Technically speaking one could say the same about the yen, since the Bank of Japan has promised time and time again to “thrash” it to give big exporters such as Toyota, Shin Etsu and Mitsubishi their much longed for 120 yen for a dollar exchange rate.
Or about the euro and the mighty dollar itself, since the central banks issuing them have stated time and time again they aim at a 2% yearly CPI increase, which for anybody having to buy real goods in a real world equate to at very least 6% yearly price increases.

Around 2010 in his newsletter Marc Faber warned the world was on the edge of a currency war. I had no idea how right he was.
Switzerland followed into China’s footsteps by trying pegging the franc to the euro, only to be forced to float it when the Banque Nationale Suisse discovered that, well, Switzerland is not China. As the BNS cannot be a gracious loser, it has been hammering the currency with some of the most ridiculous interest rates I’ve seen ever since.

Now, regarding the competition China faces.
Small shock: low low wages have always been but a small part of China’s appeal. Vietnam, Malaysia, Bangladesh etc have always had considerably cheaper labor.
China’s success is due to a combination of factors which made her almost the perfect place to invest for years.
The reasons China wants to stimulate exports through a not-so-stealthy devaluation of the yuan are closely tied to the fact they built up their manufacturing industry to have yearly 10 to 20% increases in export volume from 2005 to 2030 at least. In short massive overcapacity (in some sectors actually growing overcapacity) in face of stagnating worldwide demand and stiffer competition from abroad.

interesting

Oct 11, 2016 at 10:01 pm

“The Chinese yuan fell to 6.722 to the US dollar currently, the weakest since September 2010. It’s down 3.3% so far this year”

And it’s killing me, the work is flying out of the USA to China once again. As I’ve stated before China can build the whole project for less than i have to pay for just the steel.

How can a currency be put into a reserve basket of currencies when it’s value is pegged to a currency already in the same basket?

nick kelly

Oct 11, 2016 at 11:52 pm

Look at the comment above: China’s competitors being Vietnam, Indonesia, etc.
That’s who their devaluation is aimed at- price competitors not quality competitors.
The US has China on the brain. It may be geo-political opponent- it’s not a commercial one because there are no circumstances under which Americans sew clothes in sweat shops or assemble i-phones.
It’s like thinking Mexicans picking strawberries are taking jobs from Americans. (Actually this job is so shitty it falls to Mestizo Indians based in Mexico)

About 40 % of Chinese imports are budget apparel and consumer electronics- Walmart stuff. Much of the rest is toys, budget housewares. more Walmart stuff.
Re: electronics- the US was out before China was in. Japan took out the US 20 years ago-last TV set made in US. Then China and South Korea took out Japan- Sony just exiting TV biz.
You don’t want this biz back. When Starbucks sells a latte, they are making more than the 32 inch panel supplier to flat screen assembler.

Your competitors aren’t just the guys selling you stuff- they’re the guys selling you stuff you could make at a profit.
Just because you only see Japanese and German imports in driveways- doesn’t mean that’s it. They’re not in Walmart but are huge suppliers to US industry.
The devaluations to watch out for are yen and euro

MC

Oct 12, 2016 at 7:32 am

And the Chinese exporters are up to their old tricks again.

Last year I ordered a batch of oil pumps from China. They turned out to be surprisingly good, in line with their German-made competitors. So far not a single issue to report.
This year I ordered some samples of recoil starters for Honda stationary engines, the kind used on stump grinders, power generators, mini-escavators etc. It cost me some time to test them out, but it saved me a lot of headaches as not a single one was fit for being sold here for a variety of reasons, chief among which is the fact the steel springs used in them tend to deform in as little as a dozen pulls. Yes, all that surplus steel and they cannot be bothered manufacturing a semi-decent spring.
To make matters worse they aren’t even that cheap compared to the genuine Honda article.

Chinese exporters know most small importers like I am don’t test their products or rely on their contractors to provide QC (cue in The Three Stooges opening theme) so they’ll push their luck as far as they can and beyond. This is not to say all exporters are dishonest, but they know for a foreign firm to sue a Chinese-owned firm in China is pretty much impossible.

nick kelly

Oct 12, 2016 at 8:05 am

You are unusual in even trying a Chinese machine- most won’t touch them.
In case anyone thinks this is a racist comment- Taiwan is a different story. There is some quality coming out of there maybe because it was an easy place to travel to when the Mainland was still Mao country.
Some US etc. outfits went over there to make sure they were getting things done the way they wanted them.

‘And to make matters worse the price wasn’t that much cheaper
than the genuine Honda article’

If I understand this correctly, you were going to take perfectly good Honda engines and attach to them a vital, highly stressed part,- the starter, made in China?
Well good for you for testing them- but of course, no doubt somewhere those starters have made it into the food chain.
I’ll buy Chinese clothes and shoes etc. or dollar store stuff.
But in machinery, even basic machinery e.g. fans, China’s low prices have cost consumers countless billions.
PS: re: fans- my present big fan is the Taiwan window or box fan, 20 inches square. It’s probably 30 years old. Got it at a garage sale.
It is such a better fan than the new mainland version that I’m always looking for another.
But it will be old because the ‘China price’ aka the Walmart price drove Taiwan out of the fan biz.

MC

Oct 12, 2016 at 9:47 am

The starter is not a highly stressed component on a stationary engine. If you have an idea how a brush cutter starter is attached to the engine… that’s it. In case of an emergency these engines can also be started using a power drill.

The problem is twofold and that’s a problem most people don’t understand.
First, people these days are obsessed with cheap. If you don’t keep a cheap alternative to the genuine part, you’ll lose business.
Second, sadly I need to reduce the value of your stock while at the same time having something to sell. Taxes and inflation are chewing me up.

If I could be like Honda, meaning keeping a fully stocked warehouse in Belgium (due to tax breaks) and having the parts sent here in three working days, rest assured I’d only stock genuine parts from most brands.

d

Oct 12, 2016 at 8:10 am

If you investigate a little further, almost nothing made in china comes apart nicely, so it can be simply Maintained/Repaired and reassembled.

Japanese made things come apart nicely, so they can be repaired/maintained, even if the cost of replacement components is uneconomic, parts can still be viably salvaged from them.

Watch out for supply later in time, not consistent with tested sample’s.

A common Mainland chinese ruse.

Friend of mine, ended up with a container load of G clamps that bent under any load, like that

MC

Oct 12, 2016 at 11:45 am

Always remember the quality of Chinese goods depends on two factors.
First is the specs you give your Chinese contractor(s).
Second is having QC carried out during the manufacturing process instead of trying out the damn things after they arrived here.

Yes, Chinese exporters try to get away with a lot, but often the problem lays with who placed the order.
Just to give an example both Husqvarna and Toro have replaced the smaller US-made Briggs & Stratton engines on many of their power products with Chinese units.
These engines live up to expectations, meaning they seem designed to start giving problems after they are outside of warranty. These are no catastrophic failures but the usual accumulation of nags such as running rich due to carburetor needles wearing out so quickly you’d think they are made of cheese, mechanical governors malfunctioning etc. You can still mow your lawn, but it becomes a chore so you head out and buy a new one.
By contrast the smaller Honda GXV units we get in Europe are made in China (US market models are still made in Georgia) and you never hear of a problem besides usual tear and wear. Same thing with bottom of the line Stihl and Yamabiko homeowner products: they are made in China but they are as reliable at their Japan, US and German made brethren.

Unless you plan on riding quality fade or blaming shady Chinese contractors for decisions you took, China is becoming less and less convenient for smaller manufacturers.
Electrically heated clothing manufacturer Gerbing moved production back to the US after dealing with Chinese QC issues which were costing them more than they saved. Intriguingly enough Gerbing moved production to China to become a Harley-Davidson supplier: Milwaukee, whose motorcycles are “Made with Pride in the USA” (except for the models made in India) forced a contractor to move production to China to squeeze it harder.
And it won’t be the last time it happens.

chris Hauser

Oct 12, 2016 at 9:10 pm

it’s not a ruse, it’s fraud.

bait, switch, rip, run.

dave

Oct 12, 2016 at 12:41 am

another thing to watch is the fed. interest rates go up USD goes up so does yaun. euro and yen go down. if they stay the same usd goes down, yuan goes down.yen goes up. i think the chinese are banking on no hikes. this way they can do little or nothing and yuan can decrease a little. just like saudi arabia pegged to the usd. usd goes up all dollar debt goes with it. creates havoc.

wolf any predictions on rate hike? i predict nothing. status quo.

Jerry

Oct 12, 2016 at 4:38 am

Interest rates have to go up or the pension funds bonfire is going to be really huge.

Tom Kauser

Oct 12, 2016 at 11:38 am

Mr. Market will need QE4 and that is all that matters?

KONSTANTIN ks

Oct 12, 2016 at 1:32 am

Who might be those selling yuan for dollars; on what purpose? Do they sell their panic and simply buy security or do they buy american economy? Petrodollar maybe?

MC

Oct 12, 2016 at 8:08 am

Chinese buyers have been among the main drivers of the various localized housing bubbles in cities such as Sydney, Vancouver, Melbourne and Toronto. They have also shopped, and shopped a lot, for firms around the world: one of the most recent news is Chinese online shopping titan Alibaba is negotiating the purchase of a share in Steven Spielberg’s Amblin Entertainment.

Chinese buyers have no problems overpaying as long as they can get their yuan out of China and converted in other currencies as fast as possible. A typical example is the purchase of insolvent Italian tractor manufacturer Goldoni by Chinese automotive giant Foton Lovol. If FL just wanted Goldoni’s assets they could have just waited for the firm to be declared bankrupt and scoop it up at bargain prices. Instead they ended up overpaying it (and grossly so) to close the deal quickly.

There’s no satisfactory explanation for the capital outflow which started in 2014. Some suggested Chinese savers are worried about an “overnight” 10-15% devaluation of the yuan. Others suggested the Communist Party has leaked to the well connected (starting from its own members) extremely tight capital controls will be enacted during 2017 or 2018. Others still suggested many Chinese nationals are buying a “fallout shelter” in case the power struggles inside the Party turn violent.. Yet other suggested Chinese firms are getting a “foot through the door” in case heavy sanctions are slapped on Chinese exports.

Honestly I have no explanation because it’s all beyond insane. The prices Chinese buyers have paid for derelict houses in Vancouver and German brands long in the grave make zero business sense even in a world where easy money keeps on sending asset prices higher and higher.

d

Oct 12, 2016 at 8:20 am

Much of that money in many of the smaller deals, is borrowed against fake or worthless assets in china. To be allowed to draw the loan, they must make a purchase.

Those European brand names, can double or triple the retail price of good’s in mainland china, and mainlanders will pay it, as they think they are getting something better.

chris Hauser

Oct 12, 2016 at 9:12 pm

exactly right. asset based lending, so to speak.

Green Rock

Oct 12, 2016 at 10:13 am

Look at the Americans in Mexico 30 years ago….even 10 years ago. They bought, and over-paid. We ruined the Mexican property prices too. An old cycle. Boom country buys in a bust country. That’s the banker cycle. I’m looking forward to the end of this, regardless of the costs. This is too stupid for my energy.

I know some one who bought 1.5 acre in the jungle for $100K. No improvements. Thinks it’s a bargain.

d

Oct 12, 2016 at 3:14 am

china has bullied its way into the sdr, making the whole thing completely worthless.

This however gives china and the west, more problems, as china now has a slightly more convertible currency, even more CNY, owned by rats.

Will leave the mainland, to be converted into X Y and Z assets not CNY dominated. The problem for the west is, that there will be an increase of worthless devaluing chinese toilet paper, sloshing round in it system’s.

An indication of the problem will be available, in the reluctance of chinese banks to exchange that CNY cash, back into the mainland system.

Also as the CNY becomes more convertible, expect huge forgery issues, (Some of which will originate with the CCP) to show up in western holdings, of the PBOC Toilet paper.

Petunia

Oct 12, 2016 at 9:46 am

I don’t think China bullied itself into the SDR, as much as we sucked them in, in order not to pay off the 1T treasury debt we owe them. China now has about 11% of the SDR basket, which means they now own 11% of the global debt doodoo pile, which will be created to roll over the unpayable debt.

Globalism is making everything worthless.

d

Oct 12, 2016 at 11:40 pm

china bullied its way in and now it will bully the US $ out to make itself the global reserve.

So that it can print everybody into financial slavery, taking everything it wants from the rest of the planet, for worthless pieces of chinese toilet paper.

chinese invented paper money, and the wars that go with excessive money printing, they still haven’t learnt. there are limits to printing money.

At the moment, the $ US is still sort of worth, something.

cny is not even good for toilet paper.

Unitron

Oct 12, 2016 at 8:23 am

This devaluation is the tip of the iceberg that hides gigantic convulsions in China’s financial system, gasping for dollars like an out of water fish for oxygen, and all the foreign reserves in the world aren’t enough to keep the little fishy from suffocating. Japan too, eventually. Who would have thought that 20 years of mercantilism and financial meddling could end so badly?

Kevin

Oct 12, 2016 at 9:51 am

If there is a trillion dollars in USD-denominated debt, does that mean the money is owed to foreign (non-Chinese) banks? If so, why should that be a concern to the Chinese banking system? Just bankrupt it away.

The Chinese officials will very shortly be facing a crucial decision: they can save the banks, or they can save the country. The big five banks here are all state-owned enterprises. Instead of QE-Infinity that destroyed Japan and will destroy Europe, the Chinese can simply bail out the depositors, bankrupt their banks, and the country can awake the next day in a world where all their private debts have been washed away, albeit with the world’s greatest deflationary collapse.

A year or two of uncertainty and pain, then they’ll dominate the world.

My guess: they choose to save the banks, instead.

Unitron

Oct 12, 2016 at 10:19 am

Who’s going to do business with China without banks? And who would trust any Chinese bank after that? Mercantilist countries like China, Japan and Germany require a financial system willing to put up with a lot of funny money (cough Deutsche Bank) to maintain their trade surpluses, not the least of which are “foreign reserves.” Its funny how those reserves are turning out to be worthless. The current system is dying, only the corpse hasn’t shown up at the party yet, but it’s sure starting to feel like it’s just outside the door.

Tom Kauser

Oct 12, 2016 at 11:24 am

Its really a squeeze!
Capital flight is old news since RMB is now convertible into gold?
Each year a funding squeeze is trotted out as capital flight and a tight dollar market extends into next year?
Our next bugaboo is “end of year selling” due to uncertainty around the next years tax code??
Small caps. In May?

Justme

Oct 12, 2016 at 11:26 am

Can someone explain what the IMF SDR really is? Who gets to draw? For what purpose? On what grounds? Using what collateral? What are the financial instruments in the basket (government bonds?), and who actually owns the content of the basket?

I know what IMF generally does, which is to bail out first-world banks and bondholders (creditors) that have issued loans to third-world countries (debtors) and not gotten paid. IMF takes over the debt, pays the creditors, harshly imposes austerity on the debtors, and takes ownership of (confiscates) collateral such as power plants, power grids and water systems, and uses the income from these assets to pay down the debt. Then after some years of austerity, the cycle is repeated, with new loans issued, keeping these third world countries in an endless state of indenture and indebtedness.

I just don’t understand what the SDR really does as part of the above evil machinations. Can someone please provide a thoughtful explanation?

When the IMF makes an emergency loan to keep some country afloat and bail out its bondholders, the recipient country can choose the loan in one of the currencies in the SDR basked. So Iraq might choose dollar loans. In the future, some other country might choose an emergency loan from the IMF denominated in yuan. That’s one of the big and everyday uses of the currencies in the SDR basket.

I don’t understand what is the point of calling it a basket when the debt in the basket can be chosen/separated by underlying currency according to choice of the debtor. Then why pretend that the debt is all in one basket? I guess IMF is just like central banking: All the verbiage and terminology exists mainly to obfuscate what is really going on.

I think I figured out WHO has the “drawing right”. It is the IMF itself! Basically, the IMF can “draw” funds by asking each country to issue government debt (bonds) up to their SDR quota, and IMF can then lend the money to debtor IMF member countries. These debtor countries will generally use the bonds to pay off other (meaning: their own) bond debts, that is, bail out the Wall St (etc) lenders that would otherwise probably never get paid. So IMF basically has three purposes: (1) to socialize the third-world lending of Wall St, City, Frankfurt (etc) onto the taxpayer in the form off government binds, and therefore (2) enable Wall St to issue debt/bonds for 3d world countries without having to worry about getting paid back, and (3) thereby allowing large 1st-world corporations to sell goods and development projects to 3d world countries.

Oh, I just figured out why there is a “basket”: If some country’s currency is not a designated “basket” currency, that country must make their SDR contribution to IMF by buying government bonds from the countries that *are* in the “basket”. So the currencies in the basket are the currencies of governments whose debt is deemed solid and liquid, more or less.

Petunia

Oct 12, 2016 at 4:35 pm

Your post just gave me a headache.

The IMF is a central bank. It is the central bank of central banks. An SDR is simply a promise to lend to its holder. That holder may draw the proceeds in whatever currencies are in the basket. If the basket is short of the needed currency the IMF will buy it and those costs are passed on to the members. The interest paid by the borrower is also allocated to the members.

This is only one snap shot of what they do. SDRs are also tradable instruments among basket members and others. One of the reasons they want to pass global trade agreements has to do with how these instruments will trade in the future and where.

Justme

Oct 12, 2016 at 5:14 pm

Petunia, not sure if this reply will get into the right spot in the thread, but hopefully.

I think the whole idea of SDR *is* to give people a headache of circular logic and obfuscation, so that IMF can do its dirty deeds unhindered.

>> An SDR is simply a promise to lend to its holder.

I can agree with that, except the holder of the “right” (an option) to the promise is always the IMF itself. It is the IMF that exercises the SDR, meaning to call in the funds (presumably in the form of government bonds) when the board of IMF votes to do so, and for specific purposes such as “allowing country X to pay back its debt to corporation Y of country Z, the payment being funded by a loan from government Z.”

Presto! The risk and possible losses from the debt is now shifted to the taxpayers of country Z. As I said, this stuff is intentionally obfuscated, and for good reasons.

Petunia

Oct 12, 2016 at 6:04 pm

OK, here we go again.

The IMF issues an SDR they way a bank issues a mortgage pre approval. The holder of the SDR is the borrower, some govt or govt agency. The borrowing govt holds the option to draw down the credit line anyway they want to the credit limit, for the purposes agreed to for the loan(buying the house). The borrower pays interest and the IMF has whatever recourse was agreed to in the loan agreement. I can’t make it simpler than this because the terms can be anything.

I think your confusion is that the borrowers often issue bonds in their countries to get a revenue stream to pay off the loan. They don’t have to do this, but often do, because they want the money from the SDR. They are free to make any deal they can live with.

Jus7tme

Oct 13, 2016 at 1:27 pm

Petunia, you seem to disagree with me about what an SDR (Special Drawing Right) is. I think it is an obligation of the basket-members of the IMF to provide loans up to a certain limit, which they strangely call a “quota”. It is the IMF that holds the SDRs and has the power to vote to “draw” funds with the SDR, Special Drawing Right. They have the “option” to do so.

When some 3d world debtor country is being nailed out (unintentional but perhaps funny typo for bailed out, so I’ll leave it), I do not think they receive a transfer of SDRs from the IMF. They receive a loan or a line of credit, in one or more specific currencies. Specifically the loan is not denominated in SDR (or XDR which is sort of a “ticker symbol”). Said debtor country cannot pay their debts with SDRs. So at some point IMF must call in some underlying instruments ,most likely government bonds, that turn the SDR into a liquid instrument that the debtor country can pass on to their original creditors as payment.

For all I know you may be an expert on the IMF, but I’m not convinced your explanations are correct.

You claim that the IMF is a central bank of the central banks. I think it is not. First, the clients of IMF are not central banks, but governments and their treasuries. Second, a central bank (actually a reserve bank) is an entity that nets out payment balances between member banks on a daily basis. Reserves are the currency of interbank settlements. Reserves are created when banks deposit high-quality collateral (*) at the reserve bank, and are credited the “value” of the instrument in their reserve accounts. Interbank payments are essentially just adjusting who is assigned what fraction of ownership of that underlying collateral.

Given that IMF does not appear to have collateral on deposit, the IMF does not fit the definition of being a central (i.e. reserve) bank. The “drawing right” exists specifically because there is no collateral on deposit. If the collateral was there, there would be no need to “draw” (pull) anything.

Now, the important thing really is what the IMF *does* with the SDR, what loan contracts and terms they negotiate, who benefits (banks), who is subjected to austerity (poor people), who tales the risk and losses (taxpayers), and how the IMF has become a tool of corporate enrichment and 3d world financial oppression. BUT it is still important to understand how the SDR machinery works, since people otherwise gets lost among the verbiage, which is probably the intent of the IMF to begin with.

(*) The collateral historically was gold, then later the highest safety bonds (government bonds) were allowed, and with Quantitative Easing in 2008-2016 (ongoing), all kinds of crappy bonds are now on deposit at many central banks, and serve as backing for interbank debts and payments. BoJ has even accepted stocks as as collateral for reserves through their QE program. That is a very low-quality and unsafe asset for the purpose of being collateral. These facts are somewhat orthogonal to what IMF is and does, but since many people do not realize this, I thought I’d mention it.

Justme

Oct 12, 2016 at 1:45 pm

Wolf, I’m curious whether you (more or less) agree with my description of what the SDR really is, and how SDR are used in practice, from the creditor nation side and the debtor nation side. The official version and even Wikipedia is so obfuscated that is no use.

Wolf, I checked out those links for a bit ;-). I suppose you might be a bit tongue-in-cheek, here ;-).

“The Special Drawing Right (SDR) is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.”

Hah. Talk about obfuscation ;-). What on earth is the supposed meaning of “SDR is an international reserve asset”? Well, the SDR is not a reserve, because nobody posted any collateral for it at the IMF (yet). It is not international, because each debt instrument underlying the SDR has individual denominations. And finally, it is not an asset, because it is just a pledge to deliver certain sovereign bonds (assets) sometime in the future, upon demand. Am I wrong?

I think the IMF is probably THE master of circular definitions or definitions-to-nowhere. By the way, it looks like Wikipedia pretty much just copied the official descriptions from the IMF, completely uncritically. No wonder it is almost unreadable.

Note also the date 1969 when SDR came into existence. That was the year US went off the dollar/gold standard. While I am not into goldbuggery, there does seem to be a connection.

China is pushing up the dollar which gives its citizens a RMB deal while the government can suppress gold prices and imports?
Pulling dollars from the domestic economy and suppressing capital flight are positive while increasing exports?
I expect that China will take the lions share of IMF loans as America withdraws from loaning into restructuring/collecting past loans?
China has a tall order! Make loans and not devalue?
Small caps but not before May?

Tom Kauser

Oct 12, 2016 at 11:40 am

Pension funds can go for decades before QE will need to fund their payouts!

Bookdoc

Oct 12, 2016 at 7:56 pm

Am I wrong or does the SDR represent a non-collateralized asset? More money creation?

The SDR isn’t a currency, it’s more like a scorecard. It isn’t a good one because there is no way to ‘arbitrage’ between the IMF and currency markets, where MOST currency worth is determined.

I say MOST because what prices money is its voluntary exchange millions of times every day for a valuable (non-renewable) resource … at gas stations around the world. I know what you gold people were thinking for a minute!

What gives RMB worth is the foreign currency held by the Bank of China as collateral. Absent forex and the RMB is flat-out worthless. Being a component of the IMF drawing rights pool does not change that, it just means China is on the hook for Brazil’s debt or Venezuela’s (it’s already on the hook, there). China cannot be a credit provider because it lacks the infrastructure: it has the currency (check), the commercial banks (that can pass their losses into the economy, check), the central bank (to hold reserves, also check), the treasury (to borrow and thereby pay the interest on private sector debt = check). China, a single party police state LACKS property rights, the rule of law, an independent judiciary with a body of jurisprudence as well as enforceable contracts. Without these things China must hold collateral for each yuan they issue. Any contract in China isn’t worth the paper it’s printed on: money is a contract, too!

The commercial/loan shark banks have over-issued against collateral for years … when last heard from Charlene Chu the amounts were almost $20 TRILLION. That’s a lot of empty apartment buildings.

And you know something … there isn’t a goddamned thing they can do about it, either … except get rid of the cars.

This is what peeps don’t understand, it is the CARS that are bankrupting these countries, China, USA, EU, Russia, Turkey, Brazil, Mexico, ETC. Operating hundreds of millions of cars does cannot pay for them. What pays is LOANS: tens of trillion$ of unsecured debt.

Petunia

Oct 13, 2016 at 9:11 am

I agree with you that China has no rule of law and no property rights which is why their currency will always be at the bottom of the totem pole. But it does have some value in that you can buy usable stuff with it.

However, where I disagree with you is in that an SDR isn’t a currency and that it doesn’t affect the forex markets, it is a currency and it can affect the forex markets. It is a currency which trades in a very limited circle. It trades among members of the basket and is also redeemable in the most important banks.

If the IMF is short of the needed currency a borrower requires, it will purchase it in the open market. The borrower can also arbitrage the loan thru the currency markets. Let’s say the borrower needs rupees to pay workers building a dam, it will ask for the basket currency with the best exchange rate against the rupee. So they may ask for yen one time, and then euros the next time. All of these examples affect the forex markets to some degree.

Guito Vivas

Oct 13, 2016 at 8:41 am

“they have issued over $1 trillion in dollar-denominated debt, according to the Bank of International Settlements. And that dollar debt becomes increasingly difficult to service with a shrinking yuan.”

Which is a chinese problem -only if they care for the value of the reserves they hold. i.e., they could theoretically just pay it off with said reserves and the problem then becomes…